MauledAgain

Prof. James Edward Maule's more than occasional commentary on tax law, legal education, the First Amendment, religion, and law generally, with sporadic attempts to connect all of this to genealogy, theology, music, model trains, and chocolate chip cookies. Copyright 2004-2019 James Edward Maule.

Monday, July 31, 2017

Earrings, Jet Skiing, and Casualty Loss Deductions

A reader asked me two questions about the tax consequences of an unfortunate event that befell Atlanta Falcons’ wide receiver Julio Jones. According to this story, Jones was jet skiing on Lake Lanier when he hit a boat wake and fell into the water. When he resurfaced, he realized that his earring had fallen off his ear. He concluded that the earring, worth more than $100,000, was at the bottom of the 65-foot-deep lake. So Jones hired a dive team to look for the earring. As of the time the story was published, the divers had come up empty.

The readers asked me, “Is this a casualty loss? Can the payment of dive team expenses be deducted?”

Yes, it is a casualty loss. The facts appear to support a claim that a sudden event caused the loss. It is not unlike the case where a car door slammed onto a person’s hand, dislodging a diamond from its setting in a ring, and causing the diamond to fall in such a way that it was not found.

But the more important issue is whether the casualty loss would generate a deduction. The computation of the deduction begins with the loss of value. It is roughly $100,000. That amount is reduced by insurance recovery. There is no information on the scope of insurance coverage. If it is assumed that there is no coverage, the $100,000 is reduced by $100. The resulting $99,900 is reduced by 10 percent of Jones’ adjusted gross income. Jones has a base salary in 2017 of $11,500,000, and even though his deductions in computing adjusted gross income are unknown, his adjusted gross income is probably at least $10,000,000. So, reducing $99,900 by $1,000,000 (10 percent of $10,000,000) wipes out any deduction. The result wouldn’t change if there was an insurance recovery that caused the $99,900 to be some smaller number.

Turning to the question of the cost of hiring a dive team to search for the ring, that expense is not deductible. And if it were, it would be wiped out by the ten percent of adjusted gross income floor.

For someone with a much lower adjusted gross income, a casualty loss deduction would be generated if the lost ring was uninsured and worth more than ten percent of adjusted gross income. Though the cost-of-repair method is an alternative way to compute a casualty loss, it does not appear to have any relevance when the casualty involves a lost item. Nor are search expenses part of the cost of repair.

Friday, July 28, 2017

Getting Tax Facts Correct: Is It Really That Difficult?

George Will tried to prove a point about the federal income tax system. The point he tried to prove is a simple one, and one with which almost no one disagrees. The federal income tax system is too complicated. I can’t imagine that this observation is disputed by anyone, and so I don’t understand why George Will decided he needed to prove the point. In trying to prove the point, he made two assertions that are simply wrong.

Second, Will claimed that “America has more people employed as tax preparers (1.2 million) than as police and firefighters.” For this, he cited a US News web page that, in addition to repeating the nonsensical “70,000 page” claim, not only asserted that there are 1.2 million tax return preparers but that there are 310,400 firefighters and 765,000 police. A staff writer for the Tampa Bay Times, Manuela Tobias, took issue with this claim. It appears Will’s 1.2 million claim was taken from a 2012 article that cited a 2007 IRS figure. So Tobias asked the IRS for more recent information. The IRS reported that in 2017 there are 713,448 people with current preparer tax identification numbers. Though there may be some people preparing returns for a fee without the required preparer tax identification number, it is highly unlikely that half a million people are doing so. Will was close when it came to firefighters, with the Bureau of Labor Statistics reporting 315,901 of them as of May 2016, close enough to 310,400. On the other hand, the Bureau of Labor Statistics reports 657,690 police and sheriff’s patrol officers, more than 100,000 shy of Will’s estimate. When the dust settles, there are 973,591 firefighters and police, as compared to 713,448 tax return preparers. Will did not respond to a request for comment by Tobias.

If Will wants to prove that the federal tax system is complicated, and I don’t know why someone would want to do that, and if he wanted to focus on tax return preparation, a better measure would be the number of taxpayers who use the assistance of tax return preparers. According to an testimony before the U.S. Senate Finance Committee by the Government Accountability Office’s Director of Strategic Issues, in 2014, 56 percent of individual federal income tax returns were prepared by paid preparers. Whether 1,000 or 10,000 or 100,000 or 500,000 preparers are doing the work doesn’t matter. What matters is that tens of millions of Americans are unable to prepare their own tax returns, though some people using preparers can prepare their own returns but prefer to use their time for other endeavors.

Once George Will’s misinformation goes viral, it will be near impossible to erase it from the brains of people who absorb these sorts of claims without doing research or figuring things out for themselves. The litany of “I believed that person and I ended up being duped” cries for sympathy continues, and will continue, in part because of laziness, in part because of gullibility, in part because of human tendency to believe what one wants to hear, and in part because of the evil forces that fertilize intentional fact-twisting and outright fabrication of information. The only countervailing force is education, and that, too, is under siege. The enormity of the problem ought to be apparent when even George Will can’t get it right.

Last week, a reader directed my attention to a Judge Judy episode from 2012 that raised a serious issue of tax return preparation. The case involved a loan repayment, but the tax return preparation issue became the focal point of the dialogue.

The plaintiff made a $1,000 loan and a $300 loan to his daughter defendant. The daughter admitted that the first loan was made but did not appear to agree that there was a second loan. The daughter said she repaid $400 on the first loan. Her father said she repaid $140. Eventually Judge Judy decided to treat the daughter as having repaid $200. The daughter planned to repay the balance from her income tax refund. Because of what happened to the refund, the daughter did not repay, and her father sued her.

The daughter’s Form W-2, like her other mail, was delivered to her father’s address. The daughter had lived there for a time, had moved out several months earlier, and had, according to her, forgotten to file a change of address notice with the post office.

When the Forms W-2 arrived, the father’s wife, who was the defendant’s step mother, opened the mail containing the W-2s. She claimed that she did so with permission, and that every time mail arrived for the daughter she called the daughter and was told to open it.

The stepmother testified that when the envelope arrived from the daughter’s employer showing that it contained a Form W-2, she called her stepdaughter and was told by her stepdaughter told her to prepare the stepdaughter’s federal income tax return. She also testified that she had prepared her stepdaughter’s return for the previous year, at her stepdaughter’s request, because by using her Turbotax software it save the stepdaughter a tax preparation fee and accelerated the timing of any refund. The daughter denied having requested her stepmother to prepare the return.

The plaintiff father testified that his wife, the stepmother, called him at work to tell him that his daughter’s Form W-2 had arrived in the mail. He further testified that he called his daughter to ask her what to do with the Form W-2, and that his daughter told him to send them to her, and not to prepare a return . However, the father claimed, she refused to provide him an address so he sent them back to the employer who had sent them. The stepmother then claimed that she put the Form W-2 in the mail to the employer.

Judge Judy pointed out that the plaintiff and his wife were telling inconsistent stories. The stepmother tried to reconcile the stories by making it appear that the daughter had changed her mind between the time the stepmother called and when the father called, but that didn’t work because the father’s account was that the stepmother, on opening the mail and finding the Form W-2, called him, and not her stepdaughter.

The daughter testified that she had a subsequent conversation with her stepmother, who told her that she got the Forms W-2 back from the employer, and had prepared and filed the return on the daughter’s behalf. She allegedly told her stepdaughter that there was a refund of more than $6,000. The daughter claimed that the stepmother did this so that she and the father could get the refund and use it to make certain the loan was repaid, because they were afraid she was not going to repay it.

When the stepmother filled out the return, she filed a joint return on behalf of daughter and daughter’s husband. However, daughter and her husband had separated early in the taxable year and did not get back together until the following year. Because the husband owed back child support for a child he had with his previous wife, the IRS took the refund due to the daughter and applied it to the back child support. The refund arose from tax payments made by the daughter, because her husband apparently had no income and made no tax payments. The daughter implied that if she had prepared her own return she would not have filed a joint return and exposed her refund to her husband’s child support arrearages.

Judge Judy advised the defendant to have her father and stepmother arrested and prosecuted for tampering with her mail. Judge Judy, disregarding the alleged second loan, held in favor of the plaintiff for $800 on the first loan.

There are so many lessons to learn from this case. First, do not prepare a tax return for someone unless and until written permission to do so is obtained. Second, make certain to obtain documentation for the facts that generate return entries, including filing status. Third, when marrying someone, especially someone with children from prior relationships, enter into a prenuptial agreement, and if there are children from prior relationships, have the agreement specify the ultimate obligations for child support payments for children from prior relationships, including indemnity provisions. Fourth, when lending money to someone, enter into appropriate written documentation.

Monday, July 24, 2017

Should Tax Increases Reflect Populist Sentiment?

True, polls aren’t necessarily accurate barometers, but a new poll from Bloomberg indicates more Americans favor an increase in the federal gasoline tax than oppose it. Among those who identify themselves as Republican, the edge is narrow, whereas among those who identify themselves as Democrats the margin is wide. This news might be surprising to people like Grover Norquist, who think that tax increases should be prohibited and that taxes should be reduced or eliminated, no matter the consequences.

That America’s roads, bridges, and tunnels need repairs is not debatable. The disagreement centers on how the repairs should be funded. The poll did not ask about alternatives other than the federal gasoline tax. It did not ask about state taxes, the privatization scheme, or mileage-based road fees. Nor did the poll question distinguish between adjusting the tax for inflation or raising it beyond an amount that reflects inflation adjustments.

Twenty-six states have increased fuel taxes during the past four years. Taxpayers, though not thrilled with the increases, do notice the resulting improvement in highways and bridges.

It is telling, perhaps, that fewer than half of people who voted for Donald Trump support an increase in the gasoline tax. Oddly, the President has indicated that increasing the tax is something he “would certainly consider.” Fuel taxes, tolls based on distance whether privatized or not, and mileage-based road fees all affect rural drivers more severely. Not surprisingly, support for an increased federal gasoline tax among rural residents fell just short of 50 percent. Geography also has an impact. People living in the South are less supportive of the increase, perhaps because they don’t experience quite the same level of damage caused by the harsher weather in the north.

The plaintiff sued the defendant for repayment of a $2500 loan that the defendant refused to repay. The plaintiff met the defendant on a web site, called What’s Your Price, where men pay women for companionship. The judge asked the defendant, “So you’re paid to go on a date?” The defendant replied, “Yes.” On further questioning, the defendant explained that she had been on the site for three weeks, but after meeting plaintiff and dealing with him she stopped using the site.

The judge continued, “So you’re not hooking?” “No,” replied the defendant. “You’re not selling sex?” Again the defendant answered in the negative. The judged asked, “So you are selling companionship?” The defendant replied, “Yes.” She found the site through a good friend who had been using it.

The judge, who seemed bewildered by the entire arrangement, then asked the defendant, “What if other person wants more?” The defendant replied to the effect that it was more like a dinner, a coffee, then a price is set before the arrangement is made.

The judge asked what the plaintiff paid. The defendant said $100 for the first date. The judge asked the defendant, “How much do you get and how much does the web site get?” The defendant explained that she did not think web site gets paid.

The plaintiff explained that he the web site through a friend’s recommendation. He paid less than $100, probably $50 or $75, and that one pays only for the first date. After that, there is no payment for dating.

The judge asked the defendant, “Why pay for a date when there are other sites that don’t require payment?” The plaintiff explained he had tried other sites, but hadn’t been on them for a while. Then his friend recommended the pay site.

The plaintiff said that after the first date he and the defendant became friends, went out on his birthday, went to a movie, dated casually four or five times, and that he didn’t pay for those dates. This went on for three or four months. Then, according to the plaintiff, the defendant said she was having trouble paying her bills, and explained that she was going to borrow money under an arrangement the plaintiff didn’t think it was a safe or good way to borrow money. So the plaintiff offered to lend defendant the money. She accepted, he transferred the money, and had defendant sign a promissory note.

The defendant, in response to another question from the judge, replied that she and the plaintiff did not become intimate. The plaintiff wanted a full-time relationship and wanted her to be at her house three or four days a week, but she did not have the time. She was willing to hang out casually. The judged asked, “So if he pays only for the first date, what’s in it for you?” The defendant said that plaintiff had paid her once a week after asking if she had bills to pay, and that there were only a few times when they went out that plaintiff didn’t pay her.

The judge asked why the promissory note, which the plaintiff produced, did not resolve the loan question. The defendant explained that she signed it while on the phone during a family crisis that had arisen when she and her cousin were arguing and it brought their parents into the dispute. She said she thought what she seemed to call a “promise note” was a note for a promise to continue being friends with the plaintiff. The judge did not believe the defendant’s claim that she signed the promissory note by accident. So, based on the promissory note, the verdict was delivered in favor of the plaintiff.

The reader’s question to me is a simple one: “Is this gross income for taxpayer being paid to go out on date?” The answer is easy. Yes. Absolutely. It’s a payment for services. It’s a payment for doing something that is conditioned on payment. It definitely is not a gift.

So how is this different from a situation in which a person asks another person for a date, takes the person to dinner, and pays? The answer is that neither person is under an obligation. There’s no breach of contract if one of them backs out, or if the one who did the inviting decides to let the other person pay some or all of the cost. When I taught the basic federal income tax course, I used these sorts of dating and companionship questions to help students focus on the gift exclusion and on the definition of income generally. It was one of many reasons it was easy to get students’ attention in a tax class. Make it personal and real, and discuss transactions with which they are familiar.

I get the impression that perhaps some people are making far more than an occasional $50 or $100 from these “What’s Your Price” arrangements. It’s easy to go out on one date, pocket some cash, and either turn down the offer of a second date or continue dating while receiving payment. Do the math, don’t forget to add in the value of the meal, and consider the possibility of dating one guy for lunch and another for dinner. And on an hourly basis, it’s better than minimum wage. I wonder how many people who are doing this are reporting the income. I’m confident it’s not 100 percent, or even half that.

Wednesday, July 19, 2017

When “Taxpayer” Means “Taxpayer”

A recent Tax Court decision, Gregory v. Comr., 149 T.C. No. 2 (2017), provides an excellent, though long, primer on statutory interpretation and the relevance of legislative history. The issue in the case is easily stated. The taxpayers, shareholders in an S corporation that uses the cash method of accounting, claimed deductions passed through from the S corporation that were claimed under section 468. The IRS disallowed the deductions, concluding that section 468 applies only to accrual method taxpayers. Section 468 allows landfill owners to deduct estimated future reclamation, closure, and post-closure costs.

First, the court examined the word “taxpayer” in section 468, pointing out that the statutory text controlled, and that legislative history would be relevant only if the text was viewed as ambiguous. Noting that section 468 simply states “taxpayer,” the court turned to section 7701(a)(14), which defines a taxpayer as “any person subject to any internal revenue tax.” Because a “person,” as defined in section 7701(a)(1) means and includes an individual, a trust, estate, partnership, association, company or corporation, the taxpayers and their S corporation were within the scope of the term “taxpayer” in section 468, because the taxpayers and the S corporation are subject to various federal taxes even though the S corporation in question is not subject to federal income tax.

Second, noting that the previous definition does not apply if an applicable provision provides a different definition of the term “taxpayer,” the court examined section 468 and concluded that there is no definition of “taxpayer” in that provision. Though there are other timing provisions in the Internal Revenue Code in which Congress used the phrase “accrual method taxpayer” or “taxpayer whose income is computed under an accrual method of accounting,” there is nothing of that sort in section 468.

With that, one would think the analysis was finished. But the IRS paraded a long list of reasons that the word “taxpayer” should be interpreted as “accrual method taxpayer.” The court addressed each one.

First, the IRS pointed to section 461, which includes several exceptions to the general rule that cash method taxpayers cannot claim a deduction before the expense is paid, and noted that section 468 is not in the list. The IRS also pointed to the regulations under section 461, which provide that cash-method taxpayers can deduct some expenses before the expenses are paid, “such as * * * for depreciation, depletion, and losses under sections 167, 611, and 165, respectively.” The IRS argued that because section 468 is not listed, it does not apply to cash method taxpayers. The court buried this argument by explaining that the phrase “such as” signals that the items following it “are examples, not an exclusive list.” The court referred to similar lists in the statute, including one that refers to holidays when schools are closed, “such as Christmas and Easter,” noting that schools are closed for other holidays.

Second, the IRS argued that the term “incurred” is used in section 468, and that because the term “incurred” is used in the context of the accrual method, section 468 applies only to accrual method taxpayers. Though the court agreed that “incurred” usually refers to an expense deductible under the accrual method, it noted that the word was used in section 468 only twice, and that the word “paid,” which usually refers to an expense deductible under the cash method, is used four times in section 468. If the use of another word could be taken as a limitation on the word “taxpayer,” the presence of both “incurred” and “paid” in section 468 does nothing to support the IRS position that the provision is limited to accrual method taxpayers.

Third, the IRS then cited a canon of statutory interpretation known as noscitur a sociis, which is Latin for “it is known by its associates.” Essentially, according to the court, this argument was simply another variation on the “the presence of the word ‘incurred’ means section 468 is limited to accrual method taxpayers” argument that had failed. Though the court then stated, in Latin, that the tax collector was not helped by these arguments, it just as easily and understandably could have written, Ipsi foderunt foveam profundius (“they dug themselves a deeper hole”).

Fourth, the court concluded that the cases cited by the IRS and in which section 468 had been mentioned did not address the question it faced. Those cases involved accrual method taxpayers, and thus the question of whether section 468 was limited to accrual method taxpayers had not needed attention.

Fifth, the IRS cited the principle of ejusdem generis, a Latin phrase that means, in effect, “where general words follow an enumeration of two or more things, they apply only to persons or things of the same general kind or class specifically mentioned.” The problem with this argument is that section 468 does not have a list of things, but merely refers to one word, namely, “taxpayer.” As the court put it, “Without a generis, there is no ejusdem and this canon likewise cannot help us.” Nor did it help the IRS.

Sixth, the IRS argued that because section 468A, which permits deduction of future nuclear decommissioning costs, tracks section 468, its restriction to accrual method taxpayers should also apply to section 468. However, as the court explained, the regulations under section 461 do not limit section 468A to accrual method taxpayers, nor does section 468A do so. Moreover, even though the regulations under section 468A provide that “eligible taxpayers” may make deduction elections under section 468A, they define “eligible taxpayer” as a taxpayer with a qualifying interest in a nuclear power plant.

The court then turned to legislative history even though it had not unearthed any ambiguity in section 468. The court did so “out of a supersized abundance of caution.” It made clear that it was not doing so in response to the IRS claim that by jumping from section 468 to section 7701 to define taxpayer the court had conceded the word “taxpayer” was ambiguous. The court’s discussion of the legislative history is extensive, and enlightening, but in the end nothing was dug up to support the IRS conclusion.

The court’s description of how section 468 came into being, together with the discussion in Judge Lauber’s concurring opinion, is a marvelous exhibition of why legislative drafting often is compared to sausage manufacturing. It most likely is, as Judge Lauber noted, a “last-minute drafting glitch” that caused the word “taxpayer” to be used in section 468 without any sort of language limiting the section to accrual method taxpayers. Considering the twists and turns that the legislation endured on its way to becoming law, it is not surprising that the statute did not emerge as quite the provision that was intended. The remedy, of course, sits with the Congress. Though it is possible, it is not probable under current circumstances, that the outcome in this case will generate any sort of technical correction amendment in the near future.

Monday, July 17, 2017

Does a Ban on Chocolate Milk Presage a Chocolate Milk Tax?

Readers of MauledAgain know that I consider chocolate to be medicinal, and in many respects, essential. Of course, like any food item, it ought to be consumed in moderation.

Recently, the San Francisco School District has decided to prohibit elementary and middle school students from drinking chocolate milk. According to this report, and others, the school board has grouped chocolate milk with candy, cookies, and soda on its list of “foods bad for children.”

Eight years ago, in Tax-Free Beverages: Let Them Drink Chocolate?, and More on Tax-Free Beverages: Let Them Drink Chocolate, I explored the reactions to a proposal that chocolate milk be substituted for soda in school cafeterias, and shared a reminder sent to me that chocolate milk, like all chocolate, has medicinal properties beyond calcium, vitamin D, and other nutrients. The concern of those who advocate chocolate milk bans is the additional sugar in chocolate milk. The concern of those who oppose these bans is the evidence that when chocolate milk is prohibited, milk consumption by school children drops significantly, depriving them of calcium, vitamin D, and other nutrients present in milk. According to this commentary, “Several studies have examined the effects of drinking milk (flavored and white) on sugar and calorie intake. Two studies published in the Journal of the American Dietetic Association in 2002 and 2008 found that those who drank milk (flavored or plain) got in more nutrients like calcium, vitamin A, phosphorus and potassium and didn’t consume more sugar or calories than non-milk drinkers.” Perhaps the sugar from the chocolate milk offsets the desire to chomp down on a chocolate candy bar after drinking plain milk.

Fortunately, a solution has emerged. It is possible to purchase chocolate milk to which no additional sugar has been added. It’s an easy online search. Because milk contains natural sugar, it’s unclear why sugar needs to be added when cocoa powder is added, but perhaps it has something to do with the efficacy of the sugar industry lobby.

In any event, it appears that many school districts that banned chocolate milk eventually reversed course. It isn’t clear if they introduced no-sugar-added chocolate milk or reverted to the sugar-added variety.

Of course there is a tax angle to this. How long will it be before chocolate milk gets lumped with soda for purposes of the soda tax? Before the details of the soda tax were designed, I predicted, in Tax-Free Beverages: Let Them Drink Chocolate?:

Ultimately, several big decisions loom if a tax on sugar-laden foods moves forward. If chocolate milk is subjected to such a tax because it contains sugar, ought not white milk also be taxed? Granted, many fruits contain sugar, but I expect a “fruit exception” to be drafted into “sugar tax” legislation. If an exception is made for white milk, logic would dictate that combining exempt white milk with exempt strawberries should create tax-free pink milk. As for the chocolate milk, full use should be made of the vegetable exception. Chocolate is a vegetable, is it not?

What happened? As I noted in When Tax Is Bizarre: Milk Becomes Soda, the Philadelphia soda tax applies to almond, rice, and cashew “milk.” If chocolate milk gets added to that list, it will be yet one more reason soda taxes are not a sensible pathway to improving Americans’ dietary habits. As I noted in Gambling With Tax Revenue, “Taxing almond milk but not doughnuts belies the claim that the soda tax is designed to, and will improve, health.”

Friday, July 14, 2017

When A (Tax or User Fee) Problem Becomes Personal

According to a recent news report, Setti Warren, mayor of Newton, Massachusetts, was slightly injured when he was thrown from his bike after hitting a pothole in the town of Stow, Massachusetts. Warren also is a candidate for the governorship of the Commonwealth. Fortunately, though transported to a hospital out of an abundance of caution, he was released and told to rest. He intends to resume his bicycling as soon as possible.

It could have been worse. He could have suffered broken bones, a concussion, lacerations, or some combination. Under some admittedly less common circumstances, he could have been killed. If he had been thrown in front of an oncoming vehicle, death would not be an impossibility.

This news came to my attention thanks to a facebook post. The comments were interesting. Several people noted that their vehicles had been damaged after hitting potholes. One person told the story of someone who was marching in a parade and fell when stepping into a pothole. I’m guessing that if the person must look ahead and cannot look down, it’s a wonder no one else fell. I also wonder why the parade route wasn’t inspected ahead of time.

One comment struck me as particularly harsh. The commenter explained, “wondering what he is going to do in the state when he could not fix his city.” Warren is the mayor of Newton. He hit a pothole in Stow, 24 miles from his town. He is not the mayor of Stow. So much for facts. The commenter then continued, “Looks like publicity stunt to get name recognition.” Really? Though that is a possibility, it is a highly improbable one. There are far safer and cheaper ways to pull stunts to get name recognition.

Another person’s comment highlighted the tendency of most people to wait until it’s too late. This person noted, “not sure why an accident or an issue has to occur before anything does get fixed.” For centuries, people have figured they can “cross that bridge when they come to it,” but they forget that it is possible the bridge won’t be there. Readers of this blog are familiar with my claim that it is cheaper, in the long run, to increase taxes and user fees dedicated to highway, bridge, and tunnel maintenance and repairs than to wait until the invoice for new tires, repaired suspensions, and refurbished wheels arrives.

Would it be surprising to discover, in the future, that Warren begins or accelerates a pothole repair program in Newton? Or that officials in Stow do the same? Or that Warren puts prevention of damage, death, and injury from highway and infrastructure deficiencies on his gubernatorial platform? No. It appears to me that when people encounter a problem first-hand, their attitudes almost always change, often from one of hostility or disregard to one of acceptance or action. Problems are someone else’s concern until they become one’s own. That is why it is so easy for a person who has not had an unfortunate encounter with a pothole to dismiss the idea of taxes and user fees to prevent and repair potholes as “socialism,” or “careless spending.” Their tune changes quickly, just as it usually does when an addiction or other disease afflicting “other” people strikes a family member.

Indeed, it is sad that such a high price must be paid on account of delayed or insufficient prevention before the sensible path is chosen. Short-sightedness is no less a danger to this nation as is narrow-mindedness. Both seem to be proliferating. There is a vaccine for both conditions. It’s called education. But too many people run from education with the speed they use to distance themselves from any sort of long-term prevention program.

The reader directed my attention to an episode of Judge Faith, and this most recent show to come to my attention does not disappoint. At its heart, it is another one of those “gift or loan” disputes, but in the context of taxation.

The plaintiff and defendant had known each other since 1968. They dated during high school, and then went their own ways. About twelve years ago, they got back in touch. The plaintiff alleged they were friends, the defendant disagreed and claimed that they dated off and on throughout the twelve years. The defendant explained that they helped each other out and did things for each other. He even claimed that seven years ago the plaintiff moved from where she had been living to where he was living and bought a house there because they were in a dating relationship. Though the plaintiff initially denied that she and the defendant had date, she eventually conceded that their relationship was more than friendship.

The plaintiff claimed that from a financial perspective the relationship was one-sided. She helped the defendant because he often was unemployed and in need of money. The defendant disagreed, stating that he “stands on his own,” has a job as a truck driver, and was unemployed only a few times for short periods. He also pointed out that he did work to repair and improve the plaintiff’s house.

A few years ago, the plaintiff loaned money to the defendant. He paid back most of it, so she let it go at that point because she “was satisfied with that.” She explained it was difficult getting defendant to repay, but the defendant disagreed. The plaintiff then produced text messages corroborated her version, proving that she had to repeat several times her request for repayment.

Judge Faith asked the defendant if he had ever loaned money to the plaintiff. He replied, “No.” Judge Faith then turned to the dispute before the court. According to the plaintiff, when it came time to do tax returns, the defendant told the plaintiff he did his online, but because he was on the road and could not get a good internet connection he needed to have someone do his tax return. So the plaintiff’s prepare did both the plaintiff’s and the defendant’s tax returns. When the two of them went to sign and file the returns, the plaintiff paid both fees, and claimed that the defendant promised to repay her his fee that she had paid on his behalf. The defendant said that plaintiff’s paying the preparer fee was a gift, that the payment was just another of the things they were always doing for each other, and that he did not know plaintiff wanted to be reimbursed until he received notice of the lawsuit. The plaintiff the provided another text message, one in which she had asked defendant when he planned to reimburse her for the tax preparation fee she paid on his behalf and that she had sent before she filed suit.

Judge Faith held in favor of the plaintiff. She explained that she believed the plaintiff. She noted that there was a history of the defendant borrowing money from the plaintiff.

The lesson from this case is simple, and it’s not new. When transferring money to a person, or making a payment on a person’s behalf, be clear to one’s self what the transaction entails. If it is a loan, document it. Make it clear that it is a loan, and specify the repayment provisions. Preserve the documentation in a manner that makes proving a case, if it gets to that point, easy to do. Though it is easy for banks and other third-party strangers to act in a commercial manner when lending money, it isn’t easy in most instances when the transaction is among family members or friends. Yet that is what makes it even more imperative to document a loan, because it is much easier for a friend or family member to claim a transaction is a gift than it is for someone who borrows from a bank to claim in all seriousness that the transfer of money by the bank is a gift. In an era when almost everyone is carrying a device that can record conversations, it should be fairly easy to agree to record, and to record, the conversation in which the money transfer or payment is discussed.

This time, it was a case involving a transfer of money from the plaintiff to the defendant. The plaintiff argued that it was a loan, and she wanted to be repaid. The defendant argued that it was a gift. The plaintiff explained that she loaned the money to the defendant when he asked for help in buying a car, because he did not have funds for the down payment. The plaintiff testified that she told the defendant she had some money and could lend him $1,800. She also testified that the defendant said that he would repay her from his income tax refund.

Judge Judy reminded the litigants that the transaction occurred in May, and wondered why the defendant would be expecting a tax refund in May. The plaintiff responded that the defendant said he was still waiting for the refund. Perhaps the defendant had filed his tax return at the deadline. When asked by Judge Judy, the defendant denied promising to repay, denied saying he expected a tax refund, denied expecting a tax refund, and denied receiving a tax refund. The parties also responded to Judge Judy’s questions about their income and households. Both earned about $1,800 per month, both had a child, but only the plaintiff’s child lived with her. The defendant’s child did not live with him.

Judge Judy then simply concluded that the defendant owed the plaintiff the amount in question. She gave no explanation. My guess is that, similar to other cases, she did not think that the plaintiff, who did not have greater income than the defendant and who also was maintaining a household for a child, was in a position to, and would have decided to, give money to the defendant.

Though Judge Judy’s decision resolved that particular problem, the question from the problem prevention angle is how to deal with people who promise to make payments from anticipated tax refunds. As several television court show judges have mentioned, it’s rather common for people to ask for money or purchase something from a private individual and to promise payment or repayment from an anticipated tax refund. What should the seller or lender do?

In a commercial setting, when a person wants to borrow money or to make a purchase on credit, the lender or seller undertakes due diligence. The scope of the due diligence depends on the amount of money, but usually includes, among other things, a credit check, income verification, asset confirmation, and background checks. When someone in a private transaction encounters the promise of payment or repayment from an anticipated tax refund, what should the person do? I suggest that the person ask for a copy of the return showing the anticipated refund, proof that the return has been filed, proof, if any, that an electronically filed return has been accepted by the relevant tax agency, and a signed promissory note for the amount in question, with the amount, due date, interest rate, and other terms clearly specified.

I know, I know, people will react by exclaiming, “You sound like a lawyer,” or “You’re being such a nitpicker.” Indeed. In the long run, a few minutes or even an hour, and perhaps a few dollars, are an investment well worth making when the alternative is frustration, desperation, litigation, and friendship termination.

Friday, July 07, 2017

When “Cut Spending” Doesn’t Mean “Cut Spending”

One of the arguments used by the anti-tax crowd is a simple one. Taxes should be cut, they argue, and can be cut, because there exists government spending that ought to be cut. That argument is logical. If there is government spending that ought to be cut, that should permit the cutting of taxes, assuming, of course, that there is no deficit from past years to be offset. In many states and localities, deficits are prohibited, and thus spending cuts can generate tax cuts. Of course, the sticking point is identifying “government spending that ought to be cut.”

In his report, Boehm describes the inconsistency between Corey Stewart’s gubernatorial campaign statements and his actions as chair of the Prince William County Board of Supervisors. When running for governor, Stewart promised to veto tax increases, cut government spending, and refuse to yield to special interests. Stewart attacked “phony conservatives,” alleging that, "At campaign time phony conservatives promise not to raise taxes, but they quickly betray their promises when the special interests come calling.”

Though Stewart lost his attempt to win nomination for the governorship, he continued to serve as chair of the Prince William County Board of Supervisors. One of the issues facing the board is the request by the Potomac Nationals, a single-A professional baseball franchise affiliated with the Washington Nationals, for $35 million of taxpayer funds to help finance a stadium near Woodbridge, Virginia. Based on his campaign statements, one would expect Stewart to say, “No. It violates everything for which I claimed to stand.” However, Stewart has supported spending taxpayer dollars for a private sector business since the project was first proposed. Citizens sought a referendum on the issue, but Stewart and the Board blocked that request. That’s not a surprise, because they, like most others, surely suspect that the referendum outcome would be, “No free money for wealthy people.”

Supporters of the deal, consisting mostly of the owner of the franchise and hired help, claim that it would enrich the taxpayers. The promises of job creation and increased tax revenue are the same sales pitches used by every other taxpayer-dollar-seeking wealthy sports franchise owner. Even though the promised jobs and revenue increases don’t materialize, those sales pitches are used time and again, because those who understand the reality often, like the dismissed referendum seekers in Virginia, are brushed aside and blocked from participating.

Opponent of the deal have suggested that they would support it if the owner of the franchise guaranteed the revenue benefits that are promised. But the owner doesn’t want to do that. It isn’t difficult to determine why. It puts the risk where it ought to be, on the private sector wealthy sports franchise owner.

Boehm describes what would be the largest public subsidy for a minor league baseball stadium in the nation’s history as amounting “to a massive government-funded giveaway to a privately owned baseball team, the sort gubernatorial candidate Corey Stewart would have railed against.” He suggests, “It remains to be seen whether county supervisor Stewart has the will to keep the taxpayers' best interest in mind.” But we know the answer. Like so many other politicians who have long track records of breaking campaign promises every time one blinks, Stewart is well on the way to not doing what he says. It isn’t difficult to figure out what Stewart and his sort mean by “cutting spending.” They leave out the adjective “certain” and they avoid defining that word. Actions though, in the long run, speak more loudly than do words.

Wednesday, July 05, 2017

Tax Consequences of Savings Incentive Payments

A reader sent me a link to an article describing a San Francisco program designed to encourage people to save money by paying them cash if they meet specified savings standards. The reader asked, “taxable income or a gift”? Whether it is taxable income depends on the recipient’s deductions, credits, and other tax attributes, so that part of the question cannot be answered. The broader question is whether the payment must be included in gross income. The answer is yes unless there is an applicable exclusion.

Analysis of the payment requires an understanding the program under which the payment is made. The city is “recruiting” 1,000 people to join the program. Under the program, a participant who saves $20 each month for six months is paid $60. The city keeps track of the participant’s monetary activity through an electronic link between the participant’s bank and the city. Anyone age 18 or older Is eligible to join, though the city’s goal is to reach participants who live in the city’s “poorest households.” It is unclear whether the city will select participants based on income, or on a first-come, first-serve basis. It appears as though once 1,000 people join, the program is closed. The money being paid to participants comes from a non-profit “micro-savings” organization funded by private donations.

The reader pointed to an exclusion that, at first glance, appears to be relevant. Is it a gift? I do not think it is. The payment is transferred with the intent of causing the recipient to behave in a certain manner desired by the city of San Francisco. In some respects, it resembles compensation. Though services are not performed directly for the city, the city hopes that by encouraging people to save, they will be less likely to be evicted, and thus less likely to be part of the financial instability that imposes costs on the city and its taxpayers.

Although there are dozens of exclusions in the Internal Revenue Code, almost all of the others, by their terms, do not apply. The payments are not scholarships. They are not made on account of personal injury. They are not inheritances. They are not employee achievement awards. They are not qualified fringe benefits.

Are the payments prizes? No, they are not prizes as defined by the Internal Revenue Code for purposes of the exclusion for prizes and awards. The payments are not made in recognition of religious, charitable, scientific, educational, artistic, literary, or civic achievement. The participants are not selected without any action on their part to enter the program. Nor is the payment transferred to a governmental unit or charity.

Do the payments fit within the general welfare exclusion, an administrative rather than statutory provision? I do not think so. The payments are not limited to low-income individuals, at least as the program has been described. Nor are they paid from a state or local government’s general welfare fund. Some guidance might be found from Revenue Ruling 76-131, in which the IRS concluded that payments under the Alaska Longevity Bonus Act were includable in gross income. The payments were made to persons who had attained the age of 65 years and had maintained continuous domicile in Alaska for 26 years. The IRS explained that the payments were made regardless of the recipient’s financial condition, health, education, or unemployment status. A similar conclusion was reached in Technical Advice Memorandum 9717007, dealing with payments of gaming revenue by Native American tribes to their members. Though there are differences, the Alaska program resembles the San Francisco program to the extent that a government is using cash payments to encourage its citizens to behave in a certain manner.

Those theoretical questions lead to practical ones. Will the City of San Francisco, or the non-profit organization funding the program, issue Forms 1099 to the recipients? Will the recipients, particularly if no Form 1099s are issued, report the $50 as gross income? Would the $60,000 in total potential gross income, spread over 1,000 recipients, at least some of whom would have no tax liability even if the $60 is included in gross income, generate sufficient tax revenue to justify triggering return examinations and audits?

Giovanetti provides empirical evidence for his position, courtesy of the Tax Foundation. He writes, “California alone is responsible for 19.6 percent of the national tax cost of the state tax deduction, with New York second at 13.3 percent, New Jersey at 5.9 percent and Illinois at 5 percent. Adjusting for population, New York is #1, New Jersey is #2, Connecticut is #3, California is #4, and Maryland is #5.”

Giovanetti argues that “federal policy should be neutral toward state taxes, rather than subsidizing higher taxes through the federal tax code. And it certainly doesn’t make sense for taxpayers in low-tax states like Texas and Florida to be subsidizing high-tax states like California and New York.”

Though I agree with Giovanetti that the deduction for state and local taxes ought to be repealed as part of a genuine reform of federal income taxation, I do not agree that the subsidy aspect is a defensible justification. For me, simplification is a key element of sensible tax reform, and eliminating the deduction for state and local taxes contributes to simplification without undermining the basic principles of an income tax.

If, as Giovanetti argues, it is wrong for residents of one state to subsidize those of another, then an anti-subsidization policy should remove all federal laws that enable this sort of subsidization. The same Tax Foundation that provided the subsidy information on which Giovanetti relies also provided an analysis of state dependency on federal subsidies. The states with the highest percentage of federal aid as a percentage of state general revenue are, for the most part, states with lower state and local taxes. It’s easy to keep state and local taxes low if federal funding, financed by states with much lower percentage of state general revenue funded by federal subsidies, makes up the difference.

So what would happen if all of these subsidies, not just the state and local tax deduction subsidy, were removed? From which states would people flee? In which states would people’s economic well-being worsen?